Episode #66: Radio Show: U.S. Equities: At What Valuation To Sell?
Guest: Episode #66 has no guest, but is co-hosted by Jeff Remsburg.
Date Recorded: 8/7/17
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Summary: Episode 66 is a radio show. We start with Meb referencing the just-published book, The Best Investment Writing, which he edited. It’s a great collection of essays from some of the smartest minds in investing. Check it out.
Next, we jump into market commentary, using Meb’s recent “office hours” as our vehicle for discussion. What that means is Meb had some extra time over the last few weeks, so he opened his calendar to his followers, scheduling loads of 30-minute phone calls with various individual investors and RIAs looking to pick Meb’s brain on a variety of subjects. Meb tells us the topics which came up the most often, as well as his thoughts. There’s talk of U.S. equity valuation (and at what level Meb would start selling even before a crash), angel investing, portfolio allocation weightings, and far more.
We end with several listener questions. The first involves how Meb views market breadth in light of the growth in index investing; the second solicits Meb’s thoughts on the dangers of ETF investments if the market heads south; the third is at what valuation level the buyback component of a shareholder yield strategy ends up being a headwind.
What valuation level did Meb indicate? Find out in Episode 66.
Links from the Episode:
- 3:43 – The Best Investment Writing – Faber
- 23:26 – Extraordinary Popular Delusions and The Madness of Crowds – MacKay
- 23:37 – “What If Newton Was a Trendfollower?” – Faber
- 24:35 – What If Bitcoin?
- 25:58 – Global Asset Allocation – Faber
- 42:55 – Two blog posts about a tail risk strategy: the first and the second
- 50:40 Leuthold Group’s Green Book
- 57:00 – Invest Like the Best Podcast with Will Thorndike
- 57:06 –The Outsiders – Thorndike
Transcript of Episode 66:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the Co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey podcast listeners, welcome to a summer edition radio show. Jeff, welcome to the show.
Jeff: What’s happening?
Meb: You know, I figured we’ve done so many guest interviews and we were getting a lot of feedback where listeners were pining to get Jeff back on the show.
Jeff: As they should have been.
Meb: So we thought we’d start to mix up a few Q&A’s, we might even start doing two weeks, we’ll see. Got a little travel coming up, going to Colorado and Wyoming to see the eclipse.
Meb: You know there’s an eclipse coming?
Jeff: This was, Arnott was talking about that, right?
Meb: Yeah. So took his advice, mainly got to go see the family in Colorado but we also have family up in Wyoming, so we’re gonna pop up there and get to see the unadulterated, 100% eclipse. You’re only gonna get about half here, maybe you should come join. Do you ever been to Wyoming?
Jeff: What time is it supposed to be kicking in?
Meb: I think it’s midday, I have no idea though. You ever been to Wyoming?
Jeff: Years ago, Jackson Hole.
Meb: Summer or winter?
Jeff: Summer. Would love to ski there.
Meb: There’s no way you’d go down Corbet’s Couloir?
Jeff: Corbet’s Couloir, yeah. Nuh-uh.
Meb: Yeah, well, me neither. I’ve seen it.
Jeff: Well, just so listeners can understand, Meb and I ski from time to time and you went off some…
Meb: I mostly wait for you.
Jeff: You went off some ledge and told me the landing was fine and I went flying over and I remember trying to do some trick and I about killed myself on the landing because it was anything but fine. It was all a mogul field down there. Actually, you didn’t even jump it…
Meb: It was fine. It was fine for me.
Jeff: You just skied down…no, I remember now, you actually didn’t jump it, you skied around the side. Typical conservative, passive.
Meb: Maybe if you were using your 1980s Purple Rossignols, you would have landed it.
Jeff: I looked great.
Meb: These new-fangled skis don’t work for you. What did? Parabolics, you learned on the big cardboard ones. What are we talking about today? What do you know?
Jeff: Back up first, you mentioned family a minute ago, give us the update on Tony Huge and everything else from your end.
Meb: Things have gotten a lot easier. The, probably [SP] first week of being a new father was kind of dark, everything is wonderful now, I love it. It’s a lot of fun. He’s smiling, doing all the baby things he’s doing.
However, my brother, who I love dearly, just showed up with his three children and it’s been about 1 day, they’re like 2 to 10. I’m just exhausted. We got a whole week to go and it’s like an hour of just managing them. It’s like, “Oh, man,” I’m even more and more impressed every day of parents of large families. It is chaos.
Jeff: I have three nephews under the age of 10 and I made the big mistake of buying them these hard plastic swords for Christmas. And I bought myself one so we could battle and my, you know, shins and knuckles knocked up [SP].
Meb: No, that’s not a mistake for you because you can be fun uncle and leave. Your brother and family probably hates you forever. This year you should show up with, like, a rubber-band gun or something that’s definitely gonna cause tears and meltdown.
Jeff: All right.
Meb: Yeah, so that’s good. We just put out our new book, you know, “The Best Investment Writing,” so listeners, if you haven’t picked it up, it’s really a lot of fun, it’s 30 curated pieces from this past year. We hope that…I think it’d be really fun to do it as an annual volume. So, kind of like, those yearly “The Best of Science Fiction Writing,” except they’re investment. And it’s from some of the best writers out there. I mean, the Jason Zweig intro piece alone is so awesome. I think that’s worth the price of admission.
Anyway, y’all pick up a copy, you can get it on Amazon, let me know. We’d love to hear what you think, do you think it’s great, terrible, things new to add. The Kindle edition, everything is in color by the way, which is pretty cool. You don’t [SP] rarely see that where they do the black and white hardcover Kindle in color. Check it out, let us know and the cover, there’s no book jacket. It’s like a material unknown to man, I’ve never felt as nice of a book cover. You guys, let me know what you think. I thought it was a lot of fun.
Jeff: I would think too, if you guys hearing this are familiar with some great authors that you believe might be worthy of consideration for Volume 2, that we missed, let us know. We’re always looking for great pieces.
Meb: Yeah, we’ll do…Q4 we’ll do a crowd source, “Send us the single best thing you read in 2017.” In that way, I’d like to see a lot more breadth of, you know, of writers and we got a lot of unknown and super well-known writers in this one, everything from, you know, billion-dollar fund managers to journalists to everything in between, bloggers. So yeah, hopefully, Volume 2 will be out in Q1.
Jeff: Cool. All right, let’s jump in here. I was thinking today something you’ve recently done obviously is you opened up your calendar to some investors and to some RIAs, offering them the chance to call in and basically just chat with you for 30 minutes or so.
And I know from speaking with you over the last couple of weeks, there was a lot of commonality…or some commonality in terms of what they’re asking about and how they’re seeing the markets and their concerns. Can you give us the high-level about, and what their thoughts were, that’s probably representative of how a lot of listeners are seeing things?
Meb: Yeah, so we called this “Office Hours” and podcast listeners, you wouldn’t have heard about it unless you’re on our email list, so join through any of the websites. And we sent it out and I said, “Look, my summer’s sort of slow, I’m a new dad, I got some time to kill during the day and I just wanted to interact with clients, would be clients, people,” right?
Jeff: By the way, how many hours did you…?
Meb: Well, so it was two weeks long and my intention was to do like a professor does, office hours, this time over these two weeks and I used this calendar scheduling app. And I meant for it to be from 10:00 to 2:00 every day. So, around lunch to hang out and have four 30-minute conversations…or no, that’s eight. Anyway, I unintentionally left my calendar open from 9:00 to 4:00 every day. So I did 10 to 12 calls a day for two weeks back to back and it was…
Jeff: I haven’t seen Meb look this tired for a long time.
Meb: So if you heard me by…I’m not a huge talker in the first place so if you heard me…
Jeff: That’s false.
Meb: …so if you heard me by the final Thursday or Friday, I sounded like a frog. My voice just so gravely, but it was awesome. So I talked to people, 30-minute calls and all walks of life. We talked to people from Russia, Venezuela, Saudi Arabia, Florida, Oregon. Almost all the callers…there was like half the callers are from Oregon for some unknown reason, where it’s like 110 degrees right now.
Anyway, but it was about half individuals and half advisers or institutions. I would say about one-third of the calls, we’re just talking about the Broncos or fishing or whatever is going on in the world. Two-thirds, you know, enter business opportunities, some of our podcast ideas, some of our million-dollar FinTech ideas. But two-thirds, there’s the common themes of, kinda what you alluded to in the beginning, which was what’s going on in markets, what’s going on in the world. How best do you think we can either implement some of your ideas, or funds, or offerings, or concepts, into our practice or portfolio?
And there was probably three or four, you know, kind of things that I’d say…I would always start it off, we’d just chat for a while and then I’d say, “Look, what’s on your mind?” And kinda just wanted to get a survey of what people were thinking, you know, in general, just feedback what sentiment, what’s going on in the world. And most people, there’s kind of a couple takeaways.
A lot of people I think, going back to if you remember our original conversation near the beginning of the year, where we talked about the zero budget portfolio, a lot of people still have a ton of baggage in their portfolios. And there’s a…what’s it called? The endowment effect, where you value something higher that you currently own.
You know, a lot of people have these legacy positions and for whatever reason, they treat them totally different than they had a full account of cash and just wanted to go allocate. So their starting point is always, “This is what I own now and I want to move to B. So I’m at A and I want to move to B,” and I think it’s really hard for people just say…well, let’s exclude taxes considerations for a minute. But let’s say you had a just broad portfolio where you weren’t gonna generate a huge tax gain, but let’s say you just had a bunch of junk in there, 20 mutual funds that you didn’t know what to do with. You know. It’s really hard for people to go from there because, they treat what they own differently than what they want to own. And so, we often just say, “Just clean house, liquidate it and then focus on where you want to be.” Anyway, so that was a common theme, a lot of baggage.
Jeff: Well, how much of that is people not understanding their investments fully? Or the market’s changed, so what they bought X years ago that might have made sense then, is no longer, you know, something that they want to hold, versus it’s just purely a behavioral bias? You know, they’re basically just saying, “I don’t care, I now value this more,” as you said because of the endowment effect.
Meb: I think it relates a little bit more to my second point, which is that most people are still winging it, and just shooting from the hip. And I don’t…I should have asked this question in the next Office Hours. And by the way, we’ll do this probably once a quarter from 10:00 to 2:00, not 9:00 to 4:00 but 10:00 to 2:00.
And, you know, the vast majority of people…some did, but almost majority of them didn’t have like a written, structured, rules-based plan. Most people will say, “Well, I own some of this and I own some of that and I’m thinking about doing this and that,” and it’s the way…my universal experience is the way almost everyone manages money, including advisors and institutions. They kind of just assimilate new information every day and just kind of roll with it, right?
They don’t have like a written investment plan, and we think everyone should, which you can then deviate from because once you have a reasonable investment plan…and I said this to almost every call we did. I said, “Look, you know, first of all, let me say there’s a lot of great ways to invest.” I said, “Look, I’m happy to talk about Trinity and all these other ideas that we have, but there’s plenty of good ways to invest.”
I said, you know, “This may be a scenario where you’re happy to sit in CDs or you have your 10 dividend stocks that you’ve held for 20 years and that’s your thing, and you’re comfortable with it.” I’m like, “That’s fine. I’m happy to talk about the ways that I think are the best ways to invest but let it be known, most important thing is to find the investing strategy that’s right for you.”
And a lot of people I think get stuck in this rut of age-based investment strategy. So, say I’m a 20-year-old, I have to be aggressive because I have a long-term time horizon. But then you have a 20-year-old that hasn’t studied market history or super emotional and can’t handle losing more than 10% of their investment account. And so, you know, an advisor then puts them 100% in stocks and they go down 50% and that person is scarred for 20 years, like, they’re not gonna invest.
I had a lot of calls by the way, where it was people that were aware of their behavioral issues. They’re like, “Look, I’m my own worst enemy.”
I said, “That’s great, that’s a huge finding. At least you know.”
But they would say, “I was devastated by ‘o8, I’ve never gotten back into investment since, and I’m sitting on cash or whatever,” and you know, that was a common theme. And so going back to the age-based thing, I said there’s also 80 year olds that I talked to, they’d say, “Look, I got five million bucks, I’m not gonna spend it. I spend like $50 grand a year, so I would like to invest this intelligently but also invest it.”
It’s either going to…it’s only going one of three places. It’s going the government, it’s going to your kids, or some sort of foundation or charity, right? Like, it’s gonna get dispersed, you can’t take it with you, so as my mom always says. But so they said, “I would like to invest fairly aggressively.” But most, you know, kind of the old school, just age-based investment styles would say that you need to be conservative. You’re old, you know? Although if you go back to Edelman podcast, 80 is no longer old, they may be living to 120 now.
Jeff: Well, tell me this, you mentioned the root of this was too many investors don’t have a written investment plan. When I think of that, I wonder if “Investment Plan” just that term that has a certain amount of ambiguity and/or fear attached to it to the common investor because they are like, “Well, what does that mean? Do I need a three-page written outline? Do I need to be able to forecast what I’ll do in every situation?”
Right now, can you give us maybe just three basic questions to ask yourself, or three rules of thumb, to come up with a basic investment plan to know what might work for you.
Meb: Well, I don’t even think it has to be written. I just think you need to have some sort of plan.
Jeff: All right, but let me paint you to a corner. What are three questions to help you arrive at your own plan?
Meb: So let me tell you what the conversation I would have with people, and then we’ll see if we can figure out three questions from this, because I don’t know that I have three off the top my head, I could come up with.
So the conversation would usually lead to, “Hey Meb, all right, so here’s what my current situation is, here’s my allocation,” or “Here’s what my clients are doing, can you tell me a little bit about the way you see the world and, sorta this Trinity concept, and etc.” And so, I say, “Look, again, there’s lots of great ways to invest,” and I say, “One great way to invest, what we call the starting point almost always is…and what we call an investable benchmark is if you just went out and bought the world, if you just bought everything in the world, what would that percentage look like, and we call it the Global Market Portfolio.”
And it’s, you know, a big mix of U.S. stocks and foreign stocks and bonds and real estate and commodities, everything in between. You’re gonna be owning, you know, 50,000 plus securities around the world, so you just bought everything. And it ends up roughly like half-and-half stocks and bonds, if you were to lump everything into one category. You know, corporate bonds are, sort of, a mix, tips area mix and everything in between. But in general, it’s roughly a 50/50.
And so we say, “All right, that’s the market cap portfolio starting point.” That’s, kinda, like the bar from which we start point [SP]. The beautiful thing about that today is you can invest in that for almost no cost. Or essentially, almost free. Right?
Jeff: Why is that the bar? Seems like all you’re really getting is global diversification, why is that sort of the settings point?
Meb: That’s my default starting benchmark, okay?
Jeff: Because you need something.
Meb: For me, that’s my starting benchmark because it’s a great portfolio.
Jeff: It is.
Meb: And it’s low cost, you get no home country bias, you get the market cap portfolio. If you’re just buy the world, it’s a starting point. So there’s a lot of ways to do that. Obviously, we have one of the lowest cost ETFs in the industry that does this but, you know, if you were to buy a number of different global-asset allocation funds, that cost very little, or the Robo-advisors. This is what all the Robo-advisors do, buy-and-hold diversified portfolio.
Then I say, “But the problem with that, there’s a couple of problems.” I said, “the biggest challenge for that, for people is drawdowns.” And you go through a bear market like you did in ’08-’09, 2000-2003, and investors really struggle with drawdowns and it’s not just because the portfolio draws down, and you lose 10%, 20%, 30%, you know, like some endowments are a little more aggressive, 50%. You know, a lot of people, their draw-downs were 50% in ’08-’09.
But it’s also because it coincides with recessions, with people losing their jobs, so a bad economy often and tons of negative news flow. So all this happens at the same time as you’re having a bear market. So bear markets are happening, you know, right, like when times are good and economy is great and everyone’s full employment. That’s not the way it works. It all usually happens at once. So it’s really hard to sift through those.
And we’ll ignore the market cap differences right now. So that’s the biggest challenge of the buy-and-hold. And then the minor differences are they’re market cap weighted so you could tilt towards value, you could tilt towards momentum. We talk about this in the Trinity portfolio white paper. Then I said, “Well, you know, if you’ve known me long enough, you know that my philosophy, one of the longest things that we do at Cambria is, you know, trend-following at heart.”
And trend-following is a great investment approach but it’s also hard to comply with. And it’s hard for other reasons. It’s hard because you often look different. So, it may be underperforming when buy-and-hold is outperforming or when the S&P is ripping. And so, it’s hard emotionally to stick with that system because, your friends may be making money, your friends may…or your co-workers, everyone else is doing great.
So the whole Trinity concept we said is the combination of the two, it’s a little holistic like a yin yang sort of combination and I said, “That’s been the best way, that if you look back at a decade of, sort of, research for us. On holistically putting together buy-and-hold as a fundamental anchor, you know, so you always have some tether to what’s going on in the economy in the world. But also this trend-following component that hopefully can give you concentrated exposure as well as some risk management, if and when, we may never have another bear market era, but if and when in the U.S. we have another bear market.”
So that was kind of the summary starting point. And then, a lot of people, we went off then, down 10,000 other tangents. Another comment until you let me know you have another question.
Jeff: Yeah, let me interrupt then, if you got a second. As I’m listening to this, I’m trying to think about how this would potentially translate into the idea of a few common questions or whatnot to help listeners come up with their own investment plan, and my mind is thinking, “Well, it kind of boils down to an investor’s personal preference in between a more-risk return, less-risk return, that sort of thing, so it would slide between buy-and-hold versus active.”
But to what extent have you seen that investors, in a sense, delude themselves? In a market like right now, they’re sitting there thinking, “All right, well, I wouldn’t mind ramping up my risk return so I’m going to slide more towards active or whatever because I can handle a 30% drawdown.” But then when it comes, people get scared and, you know, every bit of logic they have in moments like this, goes out the window and then they’re just fleeing the investment plan. So how do you, kinda, plan ahead for the behaviors and the fears that invariably kick in?
Meb: And one more…one of the biggest mistakes I think, I mean the vast majority the conversations that I had, almost everyone, someone had a question or was stressing about something an investment and they see it as a binary choice.
So, “I know U.S. stocks are expensive, should I be in them or out? I know that I’ve been out of the market since ’08-’09, should I get back in?” In almost every conversation, it was either in or out and no in between. And I would often tell people, I said, “Look, you know, my dad used to struggle with this.” He’s like, “Oh man, I own silver but should I sell it or keep it?”
And I said, “Sell a quarter of it.” It’s not as much fun, you’re not gonna be gambling. A lot of people want something to cheer for, they want a lottery ticket. So they want the excitement or drama of investing, and that’s not sensible. You know, that’s not a really smart way to do it.
So many people, I said, “Look, let’s say you’ve been out since ’09 and you want to start putting money to work.” I said, “Why don’t you dollar-cost average it over the next five years and you’re can always avoid the hindsight.” I mean, the correct mathematical choice is almost always lump sum immediately because a portfolio has positive expected return. And we’re not to the point yet where a portfolio doesn’t.
A 60/40 U.S. only has a very low expected return, and we had some really insightful questions on Twitter the other day, we can talk about in a minute about that. But in general, people only wanted to think in terms of “Should I be in or out?”
And I said, “Look, let’s say even if it was a binary choice, you want to be in or out of U.S. stocks,” I said, “You know, sell a quarter of it, sell a third or dollar-cost average in, it doesn’t have to be something where you’re either in or out.”
But if we were, you know, to boil down into the top three, it’s really about finding the portfolio that’s right for you, which in and of itself a hard challenge. If you remember back to the Bernstein podcast, he’s like, “I estimate 99.9% of people can’t manage money on their own,” you know, because a lot of people that, even once you know your risk-tolerance, you know, that requires, one, a knowledge of history to understand what markets have done.
I mean, if you were to tell most people listening on this podcast that U.S. stocks would decline 80% plus before, NASDAQ declined, I think 85% in the 2000 bear market, they would find that to be surprising. You know, that’s at way more risk than they would expect.
And two, it’s hard to tell someone the risk that hasn’t been through it, that hasn’t experienced a 50% down move or 80%, 90%. So there’s a disconnect, you know, education gap, experience gap for the younger people, or people just haven’t been through it.
But eventually, the goal is to try to find something that’s right for you. Sub-corollary, it would be take less risk than more, so if you think here’s your level of what you want, add some cash. Because I guarantee you, no one, ever, will go down to their grave and say, “Man, if I only had that 7% return instead of 6%,” But living through that massive drawdown to get to the extra return, you know, the path to get there is really hard for most people.
And so, just coming up with something simple and then starting small. Like, you don’t have to go all in if you’re in or out. Anyway.
Jeff: Yeah, I like the idea of scaling and seems like it could help a lot from the emotional side of it.
Meb: Yeah. So anyway, we’ll come up with three ideas and that’ll be the next radio show, “Top Three Suggestions for an Allocation.” But, you know, there’s a lot of other things. I mean I think a lot of people if you were to probably poll the average wealth and, you know, investment size of the listeners of this podcast, or the people I talk to, if you have something like $30,000, you’re in the world’s top 1%.
If you have $30,000 to your name, you’re a 1-percenter. So almost everyone listening to this podcast, almost everyone that I talked to, but it’s always interesting to talk to people, and in the U.S. I think that number is up around $700 grand, $800 grand, let’s call it $1 million, let’s round up. If you’re a millionaire, you’re in the top 1%.
But we also saw a study that’s like they would ask people what money would it take for them to be happy in regardless of asset size, it was like triple. So I talked to everyone on the podcast, I mean on the calls, it didn’t matter if they had $10,000, $1 million, some people had $100 million to their name, advisers managing billions, family offices, these huge ones, sovereign wealth funds, everything in between. And it’s interesting the perspectives because, they all have very similar concerns. And it’s just in general, “What should I do with my money? How should I invest?”
And the takeaway is there’s a lot of great way to do it, there’s a lot of really, really, really terrible ways to do it. I probably talk about cryptocurrencies here. I just got one of my favorite books, “Extraordinary Popular Delusions and the Madness of Crowds.” If you’re a listener and you haven’t read that book, I encourage you to go read it. You should also read our bubbles paper. What’s it called? What if…?
Jeff: “Sir Isaac Newton was a Trend Follower.”
Meb: “What if Isaac,” yeah, “Was a trend follower,” and it’s a history of some bubbles and it’s really interesting because so many of these, initial coin offerings and cryptocurrencies, there are so many similarities to historic bubbles right now.
Go read all our old white paper, and there was this great, great event…I can’t remember what it was, but this guy was doing essentially like these initial public offerings where people would invest, and back then, like, you didn’t even know what the venture was gonna be. And I can’t remember the quote. It’s like, “For a venture to be described later.”
So people are investing all this money and they have no idea what they’re investing in. And you see this now with so many of these initial coin offerings. People literally have zero idea what they’re investing in and you started to see stuff like this. There’s a website called “What if Bitcoin.” And the only thing the website is, you type in how much money…if you had invested $100 in 2015, what would it be worth today? So it is a giant…Bill Winterberg had tweeted this, It’s a giant fear-of-missing-out machine, which is what fuels bubbles. I was talking to Jeff at lunch today about a cryptocurrency that had gone up 10,000% or something.
Jeff: No, it was about 18,000%.
Meb: Right. And so that’s what gets people starting to drool but if you were to ask me, I’d say, “Look man, you should probably get a lot more interested in early-stage micro-cap or angel investing because you have the same orders of magnitude possible returns.” We’re doing one upcoming with a famous venture angel coming up soon. At least those companies have potential to generate cash flows in my mind. So you guys understand my perspective on the crypto world. I previously was presently amused, now I am viewing it more and more as a giant dumpster fire for investors to lose a boatload of money. So not a lot of cryptocurrency conversations, but I had a few.
Jeff: All right, let me back up really quick, I didn’t want to interrupt your train of thought a moment ago but I’m curious. You were talking about how the global portfolio’s a starting point for anything, and I kind of questioned why and you said, “Well, it’s a great portfolio.” I don’t know if you have the numbers in front of you but, how does the global portfolio do on a return basis, a long-term return basis compared to, like, the S&P?
Meb: Great. So if you read our “Global Asset Allocation” book, it will show you…we got a chapter on the global market portfolio. And by the way, the reason I say it’s the default is because it’s literally the default. It is the global market cap. If you were to buy the world, that’s what it is. It’s in line with almost every other asset-allocation portfolio in the book. Which is, you know, it does 9% or 10% a year, historically, back to the ’70s or whenever we started the study and like 5% or 6% real.
So in line, low volatili-, it’s like 10% return, 10% volatility, you know, 20% or 30% drawdown or something nominal, then real is a little bit different. So it’s right in the middle of everything, so it’s perfectly, wonderfully, average.
Jeff: It’s weird, I mean in so many ways it seems like investing is not that challenging. We just overcomplicate it so much by trying to find the various tilts and whatnot that are gonna add a little bit of alpha. When all you have to do is go out and buy the global portfolio and then hold long enough and keep your expenses low.
Meb: And we have this portfolio, it’s the only ETF that doesn’t charge a management fee. We don’t talk, hardly ever, on this podcast about funds or strategies or, you know, offerings, but, you know, there’s a number of these low-cost ETFs that exist, and we talked about it in a blog post a while back. We said, “There’s something like 4…probably now about 6 of these asset allocation ETFs, that are under 0.3% all in, and each of them owns 20,000 securities around the world, and they’re all good choices.”
And I can’t remember who runs the rest, I think its Blackhawk or State Street, under 30 basis points. And there’s something like, collectively, 2 or 3 billion in them, where there something like 700 mutual funds that charge more than that. Many 1%, 2%, even 3% and they manage almost a trillion. So that if you’re gonna do buy-and-hold low-cost investing, global market before, you should pay as little as possible because, by definition you’re not doing anything.
You’re just buying the world.
And so that’s a generational change and I don’t know when you may see the Blockbuster/Netflix moment, you know, where all of a sudden…like, you’re seeing these everyday articles is about flows, flows in the low-cost, flows in the passive, but you haven’t…I mean, that’s a perfect example.
And even this year, there’s been more mutual funds launched than ETFs. I think a lot of people don’t touch on some of these, you know, they say, “Oh ETFs, it’s passive,” all this stuff and active management’s, you know, hitting near all-time highs in the UN [SP]. So all this stuff, it will be a generational change.
And I think to myself, I said, “I wonder what would be the next…what would be the Blockbuster moment?” And I don’t know what it is, but because I think a lot of these high-fee funds are just stuck in brokerage accounts where people forgot about them, they’re dead, you know, and it’s gonna take 10, 20 years to wash it out.
Jeff: I mean it could be the generational wealth transfer that’s happening now when it could happen over the next decade. You know, as you get these 75, 80-year-olds, 85, 90-year-olds who are gonna pass on their portfolios to their kids. I would hope, or think, that there would be some level of further analysis of the actual investments and if, you know, the people who are inheriting these are seen getting charged, you know, 125 BPS versus well [SP] they could be in for 25 BPS, you know. Especially with a stepped-up cost basis, it’s not as prohibitive to liquidate and then move into something else now.
Meb: It’s something like one in five people that inherit, or a result of divorce, get an account from their parents or husband, wife. One in five stay with the advisor, so almost everyone leaves. But, so just as I would hope for any rationality on the younger generation caring about low-costs, you know, you see Robin Hood, you know, these no-transaction-fee brokerage account which is now valued at over $1 billion.
You know, tons of investors’re using that. I’d say, “Great, people care about cost,” and then you realize that something like 90% of Robin Hood’s clients bought Snapchat on the day it IPO’d. So they learned some lessons but not the right ones, you know. So they’re low-cost, you know, just throwing all their money into a fireplace.
Jeff: Yeah, we talked about this earlier where they didn’t get picked up by the S&P, so it’s just another further slap to ’em, it’s gonna hurt.
Meb: Yeah. So, what else you got?
Jeff: Well, have we exhausted the majority of the topics which were, you know, brought to you in these phone calls?
Meb: Yeah, I mean there’s a lot of conversations like, “Okay Meb, what do you see in the world? Where do you see the opportunities?” And I’d say, “You know, look, the thesis we’ve had for the past four or five years has been consistent. It has been, the U.S. is one of the most expensive markets in the world and foreign is much cheaper, some parts of it are incredibly cheap, and you really started to see that message come to life, which has been kind of nice.
“So we went through the pain of 2014, which was foreign stock markets were bottoming. And since then, 2015, 2016, 2017 in particular, a lot of these markets have really started to get their momentum. And so, even though the U.S. is still bull market, hitting new highs, one of the longest bull markets we’ve ever seen, it’s ceded leadership and performance to the foreign markets.”
So I get a little pat on the back, I’m excited about that to see last year it was Russia and Brazil, this year it’s almost everything. A lot of Europe, a lot of emerging Europe, a lot of countries are having monster years in their stocks. And so, you have this global uptrend in equity markets, right?
Commodities are a mixed bag. You have, you know, real estate, as far as REITs are a mixed bag, they at super-low yields though they’ve had pretty good…they’ve been one of the best performing asset classes since the bottom.
Bonds, you’ve seen our thesis of looking for value and sovereign bonds to be working out great. So yeah, a lot of this is, kind of, the world looks much more like it should to us, over the past few years, which is good. But usually, that’s when it starts to surprise you again, so…
Jeff: Let’s dig into U.S. equities for a second. You know, a term I’ve heard around recently is the “melt up,” and obviously we’re upper valued, as I’ve heard you say many times, doesn’t mean we’re gonna suffer any sort of massive draw down tomorrow. But, if you’re playing this as a, you know, numbers guy, odds are not good that we’re gonna continue at these levels for an extended period.
You don’t know but it would seem to suppose that. So, but given this whole melt-up concept, are you familiar with, you know, passable markets where we’ve been on an approximate stage here where you can sort of say, “All right, well, you know, this might be another six months of explosions and we…any investors who get in now can take care of it.” I mean, it’s in a sense a market-timing question which you can never answer…
Meb: Well, I would love, one day to have…there’s a handful of people I’d love to have on this podcast and ask them this question. And you can use any valuation metric, so if you looked at all the valuation metrics in the U.S. stocks, they all say they’re expensive. There’s not a single one I can find that says stocks are cheap, okay? And it’s varying degrees.
So, some metrics like the median stock and the S&P 500, so the middle, you know, the price of sales or cash flow or earnings ratios, those are all at all-time highs. Not, you know, top decile, all-time, higher than 2,000. Other metrics that we look at, we talked a lot about ten-year pricing or price earnings ratio, so CAPE ratio, it’s not anywhere near bubble all-time highs which was 45 or 48 I think in, [inaudible 00:33:45] March…excuse me, December 1999.
Jeff: Well, where are we now? 30?
Meb: We’re at 30-ish. Yeah, a little over 30. So it’s high, but it’s not horrific. It’s been as low as 5, as high as 45, it’s been as high as almost 100 in Japan. So if you’re Elon Musk, he starts his boring company and finds, you know, kryptonite under the crust of the Earth’s surface and, you know, causes this rally to go from 30 to 50 or 100. Like, that’s possible. That’s been seen before, but here’s the challenge, so two ways you can approach…a couple different ways you can approach equity markets and one in particular.
So I asked this question on Twitter, it’s a three-part question. Part one, “Do you own U.S. stocks currently so, at a valuation of 30 CAPE?” Ninety percent said yes. Okay? So we forecast U.S. stock returns below single digits, not negative, better than bonds, but certainly nowhere near foreign stock returns or other asset class.
Two, I said, “Would you continue to own U.S. stocks if they hit a CAPE ratio of 50, which is the highest they’ve ever been in 140 years that we have data?” And it was like two-thirds said yes, they would continue to own stocks, at a point of which no person with common sense wouldn’t…there’s no objectable [SP] evidence that that investment would have a positive return.
So in history, in our global database, we’re looking at every market that’s hit 50, so China and India were in the 40s and 60s I think in the mid-2000s, Japan and U.S., there’s a handful of others, right? Once you hit 30, is like a yellow flashing light, like it’s times’re gonna be pretty meh.
40 is, your return’s gonna be negative. And anything above that it just gets worse. And so the third quiz was, “If CAPE ratio hit a value of 100, would you continue to own U.S. stocks?” and I think it was like a third, said yes. And the funny thing is if you frame this in a different way, and here’s how to put it in good perspective for people.
Take your house down the street, say, you know, it’s worth $500 grand and that’s a reasonable ratio and metric based on square footage, and priced in…like a bunch of the metrics you could come up with, any person would think it would be reasonable. Say it’s $500 grand. Say, “All right, would you pay $1 million for this house?” Like, zero people would say yes, you know. And then, “Would you pay $2 million for this house?” You know.
And so, people for some reason take a different approach to investing. I mean, you’re investing in businesses at the end of the day, and people take a very strange approach when it comes to investing in businesses, that happen to be listed on a stock exchange. And so, the question I’d love to ask, you know, Bogle or some other, you know, really awesome market participants is, “Is there a point in which you would say this is too much?”
Jeff: All right, well, I’m gonna stop you and I’m gonna ask that question of you. Let me back up here. We’re at CAPE a 30 right now. Given what you know about the upward momentum in the U.S. market right now, given what you know about historical valuations and where they often start going south, at what CAPE level are you gonna bail on U.S. equities, before they turn south? You’re just gonna get out because you think it’s too high.
Meb: Two comments. Or maybe, like, five. I always come up with the number but then when I respond, I’m like, “Three things,” and I haven’t even thought of the three things yet, I just have to find a way to get three things.
Jeff: Stop waffling and let me just…you know.
Meb: I’m gonna say a couple of things. So I have an investment approach, its’s very well talked about disclosed that I put all of my investable public assets into Cambria’s strategy and portfolios. So for me, I have, you know, it averages out to like a Trinity 3 or 4, so right in the middle. And a Trinity 3 or 4 means I have roughly half in buy-and-hold, and half in trend following.
But remember the buy-and-hold side tilts towards value. So any of the global funds are gonna tilt away or not own the U.S. at all. And not only that, those funds start to move to cash if nothing is cheap in the world. Remember the good news is, there’s a lot of cheap stuff and a lot of really cheap stuff. Cheap bucket has a CAPE ratio of around 11 right now, which is a third the U.S. And the average country I think is around 20 or 22 maybe. But foreign developed and emerging are cheaper, so the really cheap stuff is way cheap.
And then the other half of the bucket is trend-following, of which, you know, some is managed futures, some hedges based on value and trend, so the strategies that take macro value into account, own zero or are hedged, so they hedge out the value part, with the last part being price based, only that owns U.S. stocks. But it won’t as soon as they turn over. My point is I have systems to get rid of the U.S. equities if and when they need to be. A lot of which are value-oriented.
Jeff: All right, let me stop you there then. Just patronize me. We have a lot of listeners out there who have probably long U.S. equities without the various tilts and trend-following overlays and whatnot. Let’s assume you, Meb, were carrying just a basket of long U.S. equities, at what CAPE level would you get scared and sketched out, and you would just go ahead and sell?
Meb: Let’s say that I’m an investor that has all my money in U.S. stocks. And I’m a stock guy, you know? I invest in stocks based on the nonsensical dividend approach and that’s what I do. Going back to our earlier conversation of behavioral issues, I think it would be irresponsible to tell everyone that they should think in binary terms, after just saying not to.
So, however, I think you…like, here’s a reasonable, totally reasonable approach, will be like, “Look, I’m gonna invest in U.S. stocks, but if they hit a certain value, I’m gonna cut it to 50%. If they hit another value, I’m gonna cut it 25%.” You know, so that I can avoid my FOMO or hindsight regret. So if they hit 40…and you could even do it in buckets. So you say, “If they hit, 30 I’m gonna go down to 75%. If it hits 40 or 50, I’m gonna go down to 50.” And maybe that’s the lowest you ever go, you know, if that’s the way you think. And if they go to 100 or 80, you know, I’m gonna go down to 20%. And that’s a reasonable, like, that’s just a common sense checkbox. Anyway…
But that also implies the world we live in right now where there’s so many…it’s so funny, I hear the media say, and a lot of portfolio managers, they’re like, you know, “We live in a world where there’s no other choices, like, U.S. stocks or bonds usually one isn’t in a bubble but they both look terrible now.”
And I’m like, “What are you talking about? Every foreign stock market in the world, half of them are really, really, really, cheap.” So there’s better choices. Anyway…
Jeff: I met someone recently and she had told me how she’s putting…she had just gotten professional help, from a broker, that she was really excited about and her money was finally saved up and she’s really pumped about a portfolio. And when she found out that I was, you know, somewhat involved in the business, she goes, “Oh, well, let me show you what I have? What do you think?”
Meb: This sounds like a date, by the way. It shouldn’t come up on a first date, Jeff.
Jeff: So she showed me what they put her in…
Matt: Don’t worry, we have no female listeners to this podcast. If my Twitter analytics are evidence of this podcast, we’re 90% men and the other 10% are robots.
Jeff: You know, we gotta work on that, by the way. Anyway, so she showed me what they had put her in, and right now she’s holding 40% U.S equities. And she said, “This is great, isn’t it?” and my…
Meb: What’s the other 60%?
Jeff: I think she was 20%…
Meb: Foreign equities?
Jeff: Twenty percent foreign equities.
Meb: No…Almost no default advisor or allocation ever gets the equity percentages, in my mind, right.
Jeff: Well I mean, I agree, but my point is she was all excited about how the portfolio had done as well and I said, “Well, you have to keep in mind that we’re in a, you know, pretty intense bull market and a rising tide,” rising…or whatever, “lifts all ships,” or whatever. And she didn’t really understand what that meant. But my point was, “Look, the returns at this level, you gotta look more globally stock, and see [inaudible 00:41:55].”
Meb: It sounds like Jeff went out with the 22-year-old and is using analogies from the 1980s. Do you remember “Family Ties?”
Jeff: Do you think it’s reasonable that a professional money manager would have put her…right now, she started her portfolio with him last year, 40% U.S. equities?
Meb: Yeah, it could be. I mean, it depends on what the other 60% is. I mean, it could be, like, if it’s 40% U.S. and 20% foreign and 50% bonds…or 40% bonds.
Jeff: Do that math again.
Meb: I mean, like, it could be reasonable because, you know, it depends. If you’re saying, “Look, this is a 50-year time horizon and, you know, 40% equities could be fine,” you know. It’s not what I would do. But it’s not…but, again…
Jeff: [inaudible 00:42:39]
Meb: U.S. is not…let me also add, in addition to Trinity, you know, I have 10% of my portfolio in tail-risk strategies, focused on the U.S. stock market. So, you know, that goes a lot to say that…I mean that is probably, there’s not a single listener on this podcast that has that much. Or any professional advisor I know that has that much in tail risk strategies, so that tells you a little bit about how I think about the world.
Jeff: What’s that drag right now?
Meb: Well, it depends. You can’t put a cost on that. I mean, historically, we did a couple of blog posts and the white paper should be out by the time this podcast comes out, that looks at tail risk strategies that pairs them with…pairs S&P 500 puts with ten-year government bonds. And it actually shocked me but the historical returns were actually positive, so it did something like 2% a year back to the 1980s, but there’s a pretty big bond bull market during that period.
So I think a reasonable expectation would be no return, that even, you know, potentially negative but, you know we’re at, I think, a good starting point. I mean it’s like the lowest volatility on record right now.
And by the way, if you went back eight months, and said, you know, the day after the Trump election that we would then have some of the least volatile equity markets ever, no one would have taken that bet. You could probably have gotten 100-to-1, 1000-to-1 on that. You know? And that’s just such a great example of markets confounding almost everyone’s opinion at the time.
And you go back…I’ll take a little credit, if you go back…and this is my second back slap during this episode. You go back and read my tweets around the election, then a couple of them was like, “Look, you know, I hate to tell people but, you know, these…presidential election is mostly irrelevant to future returns.”
Jeff: Well, we wrote that article about the analogy was the mosquitos and the lions and what people were afraid of.
Meb: Great article.
Meb: Although I say that with showing up to work today with a huge spider bite on my face, so if I don’t make it to September, you know that a venomous something got to me. Yeah, I mean and I agree, a lot of the stuff that people worry about is not what they should be worrying about.
Jeff: A few moments ago you mentioned some insightful Twitter questions, when we were talking about U.S. 60/40. Did we cover that or was that a different…?
Meb: Yeah, that was it. That was the poll I gave.
Jeff: All right. For moving on then, we’ve touched on a lot of the stuff from, I guess, mom-and-pop investors who were calling you. Anything that you would find or we would find interesting from advisors who called you? Or is it mostly the same stuff?
Meb: I think a lot of people are interested in some kinda, the bucket of other, you know. So a handful of the podcasts we’ve done, it was like Pier Street and Roofstock, we had a lot of feedback, people seem to love those.
Real estate is kind of my nightmare, I don’t like anything that involves a hassle despite y’all having heard me talk about owning farmland in Kansas, that burned down a year or two ago. Good news is, update, I got an insurance check for it by the way.
Jeff: Was this the combine fire?
Meb: Yeah. Combine randomly caught fire and burned down an entire…it’s like the highest per acre bushel yield we’ve ever had, on the farm by the way. So yeah, I mean it’s not a particularly good, you know, super-high yielding investment but there’s a lot of sentimental value. We like going out to the farm. Actually, I just got a photo of my nephew with like a six-foot long rattlesnake. Headless, by the way.
Anyway, so anything that involves, you know, big hassle for me doesn’t always fit the bill. So a lot of people want to talk about other ideas and different things and that’s really fun for me. I mean, I love the concept of liquid alts, I like liquid alts less except, except, except for I think angel investing is a really fun, interesting, you know, area. Largely for a couple reasons that most people don’t know about.
And we talked about, we’re gonna have Jason on the podcast here soon. But a couple of the biggest reasons being, it, one, potentially eliminates a lot of your emotional choices because you can’t sell the investment, you have no choice.
Second, there’s a huge, huge tax advantage, that we’ll talk about probably in the upcoming episodes. But essentially shields your capital gains from the first $10 million, so…if you hold it for five years. So even if you just replicate the S&P in your angel account, there’s a massive tax benefit. Lastly would be that, you have the potential for these hundred X investments.
And so, because angel investments in general because you’re under, say 50 million or 20 million market cap. So if you invest in something at 10 million, it’s a lot easier for something to go from 10 million, to a 100 million, to 1 billion which we called “Unicorn,” that’s 100-bagger, much like your crypto. And they could even go to 10 billion, in which case is 1,000-bagger, I mean that is a massive logarithmic increase in wealth.
So even if you put in $10 grand into angel investment at 10 million, right, it hits 1 billion, that’s a million bucks. And so, you could have a very, very, very low hit rate, and end up with these exponential sort of outcomes.
But one of the coolest parts about that is you get to meet a lot of super-energetic, optimistic people and it tends to be young people, you know, building these really interesting companies and, you know, wanting to change the world. A lot just want to get rich, but there’s a lot of things involved in that world that makes it hard. I would love for someone to start a research boutique on the private space, we talked about that a lot. We may have to do that if no one else does. I don’t want to, but we may have to.
Jeff: I’m looking forward to hearing that podcast with Jason, that’ll be fun.
Meb: Yeah, it’ll be fun. And so, you know, we talked a lot about alts, and to a lot of people that means different things but we went down a mini rabbit hole, so we’ll open this back up next quarter, for a couple weeks if you missed it, to chat about other stuff as well.
Jeff: Cool. I’m thinking here, why don’t we hit on maybe a few Q&A…
Meb: Cool, let’s do it.
Jeff: …from the listeners and then we wrap it up. “Relation of market rise and breadth, is an interesting relationship, sometimes as you have mentioned often, but I cannot help but think that indexation must have a not subtle effect on breadth. What are your thoughts?” So, but let me back up. Why don’t you define everything, make sure everybody’s on the same page first.
Jeff: Yeah, I mean breadth is like if you look at the S&P 500, it’s, a lot of the traditional metrics and indicators are such that…a classic one is, you know, how many are up or how many are down over a time frame, or on the day or above the 200-day moving average.
I was listening to Mark Yusko on “Adventures in Finance” podcasts, talk about the percentage of companies above the 200-day moving average, is a great indicator. And so, it’s basically saying, you know, is the market being supported by just a handful of stocks? You know, there’s a lot of talk of the FANGs, Facebook, Amazon, Netflix, Google, you know, lately. And it’s because, particularly in the late ’90s, that bull market was a small percent of the universe bubble. So it was the tech companies, but it wasn’t small caps and it wasn’t dividend-paying value stocks, right?
Those companies did not have a bear market 2002-2003 at all. Nasdaq fell 85%, every headline was terrible. The world was coming to an end. Most companies did just fine. And so, breadth, you know, you start to see some divergences and it’s kind of, you know, like this latticework of information, where a lot of times you’re trying to put together different pieces. And some things would give you hints sometimes and sometimes they won’t.
So I’ve long looked at breadth. I think it’s interesting. You have to take into account, you can’t just look at everything exchange-traded. Tom McClellan, who’s been on the podcast, does a lot of good work here because there’ll be closed-end funds, there’ll be ETFs which have known bonds. So you want it kind of pure universe, and want it to be not survivor bias, all that good stuff.
I’ve never found anything other than it being interesting and kind of coincident, but I’m sure lots of other people have. So it would be an indicator that I think is, could be very helpful. Leuthold writes a lot about it, they did in this current issue. If you can get access to Leuthold’s “Green Book,” it’s like Christmas Eve every month when it comes. I love it. It’s probably my favorite publication.
Jeff: Well, given the specifics of this listener’s questions, it seems like, in addition to just questioning about breadth, he’s asking about the effect of indexing on breadth. Do you find that that somehow dilutes the efficacy of this or is it irrelevant?
Meb: You’re starting to tread into my single least-favorite media topic today, which is the index and passive and ETF flows. And it’s often, I mean, Paul Singer just came out with one of the stupidest comments. But something like, you know, “it’s, they’re anti-capitalism, it’s destroying capitalism.” and it’s such a moron-…
Jeff: What, passive is?
Meb: ETFs and just passive. It’s so moronic and it’s so ill-informed, and I’ll give you a couple reasons. One, I mean, his argument, I think, is a little more that, by indexing you’re removing a lot of the traditional active involvement to vote on issues in boards and shareholder activism.
But the thing about markets is, if a stock gets too far away from its intrinsic value, someone will come in and do something. You know? So he will come in and do something, he’ll get 10 of his friends. I guarantee you if a stock get too cheap, Warren Buffett will buy it, you know. There is no question that…so there’s a couple of things.
Jeff: Isn’t that the question though, as indexing rises as much, does that basically take away the opportunity for single-stock investors to, you know, correct those imbalances?
Meb: No, that makes no sense. On top of that, I mean a lot of these active managers are complaining because they’ve been underperforming the market for a long time. And again, the whole active/passive thing to me, is a bit of a nonsensical debate. Meaning people that are trying to beat the market have struggled, and they’re pissed off because a lot of…because Vanguard is destroying them. Which is awesome because these people charge way too much, for doing very little.
So I would think…but again, going back to the active funds hitting all-time highs, and, you know, and having more fund launches in ETFs. Mutual funds are still 5X ETF assets. 5X, not equal…if you listen to the media, you would think that ETFs are like, a hundred times the size of mutual funds.
Mutual bonds are five times as big as ETFs. Mutual funds are two-thirds active. So this whole passive [inaudible 00:53:12] in the world thing, which is a good thing, is silly. If you look at institutional ownership of ETFs, across pension funds, across asset managers, advisors, it’s like 1% of their funds are in ETFs. Some, it’s less than 1%. And I tweeted that out about a year ago, but at some point, I give up and I just can’t take it. I just can’t even engage.
Jeff: You get so annoyed by that.
Meb: It’s because it’s just such bad homework. It’s like you’re not even…it’s people writing about something and not even putting any thought into it whatsoever.
Jeff: What was the quote? It was the general idea was it’s not about active or passive, it all boils down to fees.
Meb: Well, you’re totally mangling a Bogle quote but it’s close.
Jeff: Yeah, I don’t think was Bogle.
Meb: It’s Bogle, and he said, “The conflict of the industry…The conflict of interest in the industry is not active versus passive. It’s high cost versus low cost.”
Jeff: Well, I’m glad you said it better. Whatever.
Meb: Yeah. “New attribution,” Jeff Remsburg.
Jeff: There you go.
Meb: Oh, it’s 2017.
Jeff: Did I cut you off on this one? Is there more you want to say on it?
Meb: No, I didn’t want to say anything on it but I couldn’t help myself.
Jeff: All right, next question. I will preface this by saying if you guys are interested in this following topic, listen to our podcast with Dave Nadig. I think he covered this in more detail but the question is, “I’d like to hear what you and Meb have to say about the ETF bubble?” He’s worried about downside liquidity during sell offs, misallocation of capital below ROIC companies, and yada, yada, yada.
Meb: I mean it’s kind of a tangential to the last question, namely that ETFs or…ETFs are just a wrapper. So people talk about stuff, they’re like, “Wow, back during this last liquidity event or flash crash.” No, that was stock driven and we talked about that with Nadig. Stocks were the issue, not ETFs.
So ETFs are the same…pretty much the same exact thing as mutual funds, closed-end funds, all these other wrappers, and that’s all that it is. Mutual funds, the difference is they do it once a day. If they traded throughout the day, they look exactly like ETFs.
Closed-end funds have no tie to net asset value so they can trade around it, but they’re all just wrappers and they own. And it really doesn’t matter. The only exception is if you have a tiny asset class and a ton of money floating in and even…we just talked about this with Emil Van Essen on commodities, where you put enough money to something, it will move the asset class. So, if you have, you know, some tiny sub-asset class like, social media micro-cap stocks, and you decide to do an ETF on that…they would never get approved. But if you did, then you put $100 billion in it, it’s going to affect the stocks.
But for the vast majority of the world, it works great. And there’s some areas like corporate bonds that probably shouldn’t be, like, we would love to do a catastrophe bond fund, you know, on these reinsurers that insure a risk for hurricanes and earthquakes because it correlates nothing, you get a decent yield.
They’ve been pushed to kind of lower yields now but, historically it’s been a great asset class. You can’t do that as an ETF. It’s a terrible idea. Some people do it as mutual funds but I think they have a longer lock-up, it could be a closed-end fund. But there’s some assets, it just makes no sense to put it into an ETF structure. So other than a tiny few areas, it’s a totally fine structure.
Jeff: All right, so sleep well. Third question and let’s call it a day. Actually, it’s kind of ties into what we were discussing earlier in terms of market levels, valuation levels. “With stretched valuations in the U.S. equity markets, is there any valuation level that the buyback component of the shareholder yield ratio could actually create a headwind for the strategy?”
Meb: You know, I just listen to Patrick’s Invest With the Best podcast with Thorndike who wrote the book, “The Outsiders,” one of my favorite books. Buffett recommended it. If you haven’t read it, go pick up a copy. And he talks a lot about dividends, and buybacks, and finding CEOs that, you know, are good capital allocators. And he says that, you know, “The sexy part of the business and what everyone focuses 99% of the time on, is operations. And, you know, what’s this company doing, what products is it producing? Yada, yada.” But really, he said a lot of the value’s driven by a capital allocation.
Some of the best CEOs, when their stock was expensive, you know, they would be net sellers and acquiring other companies for stock. And then when their stock was cheap, they would be buying it back, etc. So well, you’d like to see people that are agnostic. Now, so there’s kind of two challenges, one is that…and we just saw finally, a competitor finally come in, and is launching another…I think it’s Blackrock, launching a shareholder yield-style fund, which I’m pretty sure doesn’t include valuation.
So any of these ways of doing dividends or buybacks, or the correct way, which is both, if you ignore valuation, I think it is very foolish because, it doesn’t matter if you’re a company that’s buying back stock or a company that is paying high dividends. If that stock is expensive, it’s a stupid idea.
Doesn’t matter if they’re distributing cash flow, like, you want to be buying cheap first, you know, then doing correct investment decisions. It’s the only way in my mind, you know, that we try to do it is through objective measures.
Now, if you’re talking about a stock market as a whole, you know, you tend to see a general trend of buybacks that ebb and flow with the market cycle. You know, you see more in ’07 than you do in ’08 or ’09. And then it kind of comes back up and you see a lot more buybacks over the last few years. That’s on aggregate though. And you really don’t care about on aggregate what the distributions are because remember, buybacks are the same as dividends, over time, excluding taxes. So it’s not something I sweat. There’s two separate questions, “Is the market overvalued?” and then, “If you’re picking stocks in the stock market, are you picking cheap ones?”
Jeff: Well, to what degree is the answer to this question not far simpler, as just, anything above intrinsic value is overpaying.
Meb: Right, so you don’t want just U.S. stock market in general in the first place, so you can apply shareholder yield to foreign developed and emerging and it works great. It has been working great.
But it’s probably the value lever that’s working more and, you know, that’s…we always say, the big muscle movement is value, rather than…and we’ve done enough ad nauseam on this, on dividends. The way to think about it, U.S. stock market’s gonna return less than normal, let’s call it 3% maybe, who knows? Four percent, 5% if you’re an optimist.
We did a great post the other day that…I forgot about this. I was looking at my Twitter feed and it had like Bogle, Shiller, GMO and like, Huntsman [SP] and some other just famous investors. We had the historical rate of return on the stock market, 6.7% real, so round that up to 9% or 10% nominal. But 6.7% real. Every single one of them was below, you know. But what do investors expect?
Through all the surveys, they expect 10% plus returns, so misalignment. So you just have lower expectations and then you can say, “Hey look, if we’re buying the cheap stocks within that stock market, add 1% or 2% or whatever,” I’m being cautious here, but adding a few percent above the market return. So you’ll still, hopefully, beat the market because you’re buying the cheap stuff. But that market may not be giving you the opportunities. Not enough breadth, that’s why you want to look globally.
Jeff: There you go. All right, we’re sitting at an hour. Anything else that you want chat about before you wrap up?
Meb: Lots, but we’ll hold off for another radio show. And listeners, the more questions you send in to Jeff, the more chance you have for us doing a lot more radio shows. We may do these once a week because we have so many guests lined up, over the next two months, that are awesome. We kind of have to either add them as supplements or boot some of the guests down the line and there’s so many people we want to talk to, I really don’t want to boot them. So send the questions to Jeff, [email protected]
I think we’ve crossed 200 reviews.
Jeff: Finally? Have we? Good.
Meb: I don’t know. I saw it like 197 a couple of weeks ago and I haven’t looked since, so I hope so.
Jeff: We’re over 1.5 million total downloads, which is another milestone for us for that.
Meb: So that means, of the 1.5 million downloads, about 0.0001% of viewers have left a review. So Jeff and I put a lot of work and sweat, I’m particularly sweat. The radio room doesn’t have air-conditioning somehow, and so it’s like 105 degrees in here. Anyway, we put a lot of effort in, we would love to see your reviews. We love reading them, they’re a lot of fun. More fun than my first book, the new book review that got taken down by Amazon.
Jeff: That was great.
Meb: So good. Sorry you guys missed it, but the guy was complaining about the price of the book at $15. No, no, he’s complaining about the price of the book at $25 even though the Kindle is $15. Not having read the book, not having ordered it and then he said, “Greed anyone?” Which is even funnier because all the proceeds go to charity.
So anyway, send us an email at [email protected], please leave us a review, we love reading them. You can always find the episodes, the show notes, yada, yada at mebfaber.com/podcasts. Thanks for listening friends, and good investing.